Home loan borrowers seem to have concluded that interest rates are unlikely to stay at such low levels indefinitely. And that they would be well advised to secure these prices for as long as they can.
“The proportion of fixed-rate loans is increasing,” report the economists of the Commonwealth Bank. “Around half of all home equity loans in April were at fixed rates.
“Fixed loans made up around 45 percent of investor loans a month.”
And of course, the sharp rise in house prices has been accompanied by a corresponding increase in the size of the average home loan.
“The average loan size has skyrocketed in the last few months,” emphasize the Commonwealth Bank economists. “Rising home prices mean buyers will generally need to borrow more than they did before.”
Of course, the growing popularity of fixed-rate loans, which traditionally only make up around 15 percent of mortgage loans, even reflects the immediate monetary measures the reserve bank took over the past year to protect the economy from the chaos caused by the coronavirus pandemic.
To ensure the country’s businesses and households were adequately supplied with cheap finance, the reserve bank allowed the country’s banks to borrow $ 200 billion in three-year funding at an extremely low interest rate of 0.1 percent.
To emphasize its commitment to keep interest rates extremely low for an extended period of time, the reserve bank has set a new target for three-year bond yields of 0.1 percent.
Armed with ample supply of ultra-cheap finance, the country’s major banks plunged themselves into a difficult position to increase their share of the attractive home loan market – where their problem loans have remained low despite the economic disruption caused by the pandemic.
However, as the economic recovery intensified, the reserve bank has started to cut back some of its emergency financial aid.
It has already been announced that banks will only have access to the remaining roughly $ 100 billion in cheap three-year funds until the end of June this year, which will remain under the term of the financing facility.
And most economists expect the reserve bank to keep the April 2024 bond as a target for the three-year target rather than postponing it to the next term, the November 2024 bond.
Economists believe that this subtle weakening of monetary stimulus will ultimately lead to a slight spike in longer-term bond yields in wholesale financial markets, which in turn will raise fixed-rate borrowing rates.
And this should draw more heat away from the scorchingly hot residential property market. Already, the pace of the price is increasing seems to have softened as buyers increasingly realize that the rock bottom borrowing costs won’t last forever.
But the real challenge for the legions of debt-laden home borrowers will, of course, arise when the reserve bank raises its official interest rate, which is currently at the historically low 0.1 percent.
The reserve bank has continuously sought to address these concerns, stressing that it will not raise official interest rates until it is confident that actual inflation remains within its target range of 2-3 percent on a sustained basis.
To do this, the labor market would have to tighten significantly in order to drive much stronger wage growth. The reserve bank estimates that this will happen in 2024 at the earliest.
However, market participants believe the reserve bank is overly pessimistic about the strength of the economic recovery and the outlook for inflation. In fact, market prices suggest that official interest rates are expected to be around 1 percent through 2024.
Regardless of the timing, the central bank has no choice but to take into account changes in the mortgage market when the Reserve Bank starts raising official interest rates again.
First, the reserve bank must take into account that borrowing has increased. This higher debt burden means that an increase in official interest rates will dampen consumer spending more than before.
At the same time, however, the growing proportion of fixed-rate loans means that the rise in official interest rates has a slower impact on macroeconomic activity.
That’s because people who are tied to fixed rate mortgages do not need to suspend repayments even if official interest rates go up.
Although isolated from the immediate effects of higher official interest rates, home loan borrowers are likely to be very aware that their loan repayments will increase at some point when their fixed rate loan ends, and they will need to extend it at a higher rate.
And of course, this could be a significantly higher rate than they previously paid on the ultra-low fixed rate home loan they took out after the pandemic.
And that will be another factor that the reserve bank will have to weigh carefully in any future rate hikes.
When it comes to extending their fixed rate loan, borrowers won’t just face an increase in the reserve bank’s official interest rates. Instead, they will face the entire increase in borrowing costs from the time they first took out their loan.
Borrowers from non-bank mortgage lenders will also feel the sting of rising interest rates as the reserve bank begins to scale back its emergency financial aid.
This is because non-bank lenders indirectly benefited from this support.
The Reserve Bank’s $ 200 billion funding facility meant the country’s banks didn’t have to raise money by issuing asset-backed securities.
Non-bank home equity lenders, however, quickly took advantage of the banks’ absence from the market to increase their own issuance of bonds backed by residential mortgages. And they were able to take out loans on very attractive terms.
The reserve bank’s statement on monetary policy states: “The spreads for residential mortgage-backed securities (RMBS) have narrowed significantly in recent months for both non-banks and banks and are well below pre-pandemic levels.”
Indeed, the statement stated that “RMBS spreads are at their lowest level since 2007”.
According to the statement, “Market commentary suggests that the low issuance of bank bonds is contributing to these low spreads as investors switch to other securities, including RMBS, that are viewed as substitute investments for bank bonds.”
The author owns shares in the big banks.